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Italy’s shifting gas sector dynamics make strong case for easing storage rules

Italy's heavily regulated gas storage system is starting to look like a poor fit with the current realities of the domestic and European gas markets. Could its reform help tackle high energy prices?

"I wasn't trading yet. But I remember it very well—my school closed for 10 days," said an Italian gas trader, sharing memories of February 2012, when several days of freezing temperatures across Europe and Russia triggered a sudden cut in Russian gas volumes destined to Italy.

The break in supply triggered a brief crisis of the energy system: households in many parts of the country were left with no power for days, and industrial plants forced to close or to shrink their production.

After that supply crisis, the Italian government introduced storage gas regulations that are still in place today. Strict injection and withdrawals levels were set spanning the whole year, to ensure that large enough volumes were stored during the summer and that market participants could extract the highest level of gas for the longest period of time during the coldest days of winter.

The system became known as "La Curva"—the curve—from the typical seasonal pattern visible in charts.

Italy gas stock levels 2018-2020

However, almost 10 years after that big freeze, it is no longer clear that this regulated system is still the best option for a gas market that now has a very different supply and demand profile.

It is true that some flexibility has been introduced over the years—for example with a fast cycle storage product allowing traders to inject and withdraw when they like. But for some in the market, this still falls short.

The European Federation of Energy Traders (EFET) has asked repeatedly for more flexibility in order to increase market efficiency and therefore lower commodity prices.

In a recent paper published in Oct. 2020, EFET wrote: "With 17 bcm of storage capacity available, of which 4.5 bcm is held as strategic reserve, Stogit [the major Italian storage operator] has ample capacity to offer additional modulation products that have no restrictions on injection or withdrawal […]. This would be similar to the fast cycle product, but in much greater quantities […]. Unrestricted modulation capacity can best react to any supply-demand imbalance and consequently increase market efficiency, leading to lower commodity prices."

There have been significant changes in the makeup of Italy's gas supply since 2012 that warrant new analysis to calculate the costs and the benefits of the current storage system. Especially since, as some market participants are suggesting, a higher level of storage withdrawals during the winter could help reduce Italy's reliance on its most expensive import route, Passo Gries, and push down the price of one of the costliest gas contracts in the European market.

A new scenario

The supply situation in Italy, and indeed in Europe, has changed significantly since 2012.

Italy increased its reliance on Russian gas in 2019/2020 after the three long-term buyers of Algerian gas—ENI, Enel and Edison—revised their contract and almost halved the annual intake. However, other changes are compensating for the loss of these long-term volumes.

Italy gas supply 2020 vs 2012

Algeria's Sonatrach has offered the three long-term buyers the option of purchasing spot gas—with monthly and quarterly nominations—on top of their annual intake, according to industry sources. This means Italy could have access to more gas from the North African countries if there were another occurrence of freezing temperatures combined with a shortage of Russian supplies.

The launch of the Trans Adriatic Pipeline, which will carry up to 8 Bcm/y of gas from the Azerbaijani section of the Caspian Sea to Italy, will also help compensate for the reduced Algerian long-term volumes, while offering further diversification of gas supply.

TAP also connects Italy to the Greek gas system, including access to the country's LNG terminals—the existing Revitoussa facility and the planned one at Alexandroupolis. These could be further sources of gas supply in case of interruptions to northern import routes.

In addition, the construction of the 2015 Bordolano storage facility increased storage operator Stogit's capacity by 1.2 Bcm of working gas to a total of 12.6 Bcm in 2020, further consolidating Italy's position as the European nation with the most working gas storage capacity

Outside Italy, changes in Ukrainian storage rules should also be considered. With the introduction of the Customs Warehouse system in 2017, Ukraine suddenly increased Europe's storage capacity, offering a big supply cushion for Europe, including Italy, in case of a severely cold winter and low Russian supplies.

There are several European trading houses making use of the Customs Warehouse regime, which allows foreign and domestic traders to store gas in Ukraine facilities for up to three years without paying value-added tax or custom duties. Traders can export Customs Warehouse volumes back to Europe, also without levies. Taxes are paid only when stored volumes are sold to Ukrainian companies and imported into Ukraine.

At the end of summer 2020, 10.1 Bcm of gas were injected in Ukraine under the Customs Warehouse regime.

The role of Passo Gries

Ultimately, the choice facing the Italian authorities is between preserving absolute security of supply—i.e. eliminating the risk of big price spikes during few winter days—and giving traders more flexibility to manage supply using storage. The latter option would potentially reduce reliance on the current marginal pipeline supply route and bring costs down more broadly, albeit with the risk of elevated prices on peak demand days.

As in every other gas market, it is the most expensive supply route that sets the day-ahead price of a hub, and for Italy, this is the Transitgas pipeline, which crosses Switzerland and links to Italy at Passo Gries. Importing even small spot volumes via this pipeline can cause Italian spot prices to increase their premium versus the reference Dutch TTF gas hub.

As one industry source puts it: "What's the current economic advantage of security of supply versus the higher price scenario created by capped winter withdrawals? This is what we need to recalculate."

Reducing the level of regulation, or abolishing it completing by switching to a commercial system, will contribute to lower gas prices, according to Patrick Heather, Senior Research Fellow at the Oxford Institute for Energy Studies.

"A commercial storage system would result in lower prices for storage services, since they would have to be more competitive. A removal of regulation should also attract more players to the market," Heather said.

After almost a decade with a very rigid storage system, Italy should acknowledge the transformation of the Italian and European gas landscape and undertake a new analysis of the benefits and drawbacks of its current storage regime.

Security of supply and lower prices don't have to be mutually exclusive: it's time for Rome to recognize this and organize the country's facilities so that both are guaranteed to Italian consumers.